Bond Retirement

What Is Bond Retirement?

Bond Retirement refers to repaying the principal amount of a bond issued to bondholders upon the bond's maturity date or in the event of early redemption. Retirement is the final stage of a bond's life cycle, where the issuer repays borrowed funds to bondholders. Hence, interest payments stop upon maturity.

For issuers, the retirement of bonds is an essential component of debt management since it shows their capacity to meet payment obligations and preserve their positive credit reputation. Reducing borrowing costs and maintaining credit ratings are two benefits of proper bond retirement. It enables issuers to recover their financial flexibility and meet their debt obligations.

• Bond retirement is the return of the principal amount of a bond issued to bondholders upon its maturity or if it is redeemed early. It is the last phase of a bond's life cycle, and the issuer pays bondholders back, thereby returning the borrowed money.
• A successful retirement guarantees the full repayment of the amount owed to bondholders and enhances the issuer's reputation, credibility, and creditworthiness in the market.
• Bonds usually cease to accrue interest upon maturity. After the maturity date, the issuer's financial obligations to the bondholders end as long as all the outstanding payments have been made.

Bond Retirement Explained

Bond Retirement is the date of maturity, which signifies the commitment of the bond issuer to repay the bond. Generally speaking, maturity indicates when the investor will receive their money back. Bonds can be retired through sinking funds, maturity, call (redemption), and refunding, among other methods. It applies to all kinds of bonds, such as corporate and government bonds. Several other forms of bonds exist in financial markets, including fixed-rate bonds, zero-coupon bonds, convertible bonds, etc.

As the bond reaches its maturity date, interest payments on bonds cease, and the issuer repays bondholders the principal amount. Bonds can also be redeemed by the issuer before their maturity date under call or redemption terms. Bondholders will receive payment of the principal amount, interest that has accumulated, and, in some situations, a call premium if the issuer chooses to call the bonds. This enables them to take advantage of decreased interest rates, cut debt, or change the capital structure of the business.

A sinking fund is an account that the issuer sets up to retire bonds gradually over time. It is done by purchasing and retiring a portion of the bonds through a lottery system or the open market with periodic payments. This approach lowers the risk of defaulting and aids in managing financial commitments.

Bond refunding entails the issuance of new bonds at a reduced interest rate to replace the existing bonds, with the proceeds going toward the immediate or future retirement of outstanding bonds. The prevailing interest rates and issuance costs are some considerations issuers focus on while making this decision.

Examples

Let us study a few examples to understand the concept better.

Example #1

Suppose Ivory Corporation issued a 10-year corporate bond to raise funds for expanding its operations. It is increasingly important for Ivory Corporation to make the payment on time as the retirement term draws near. Making payments on time guarantees Ivory’s trustworthiness and positive reputation in the industry. It displays the company's dedication to meeting its financial responsibilities and gives bondholders confidence.

Ivory Corporation can potentially improve its capacity to seek future funding at favorable conditions and fortify its ties with investors by making the payment on schedule. Furthermore, timely payment helps Ivory maintain its financial stability and successfully pursue development prospects. This is attained by reducing default risks, potential legal repercussions, and harm to the company's creditworthiness.

Example #2

Let us discuss a bond issued by the US government named the Pacific Railroad Bonds, which throws light on how bonds gradually became popular. A federal law known as the Pacific Railway Act of 1862 offered loans and subsidies to support the building of a transcontinental railroad across the country. The plan was to focus on the 32nd parallel as the initial route and use government bonds for funding. The act required the United States to issue bonds to a company with one thousand dollars each, payable 30 years after the date, with a 6% per-year interest rate. The bonds were paid in US Treasury notes or other legal tenders.

Example #3

Suppose an investor, Sally, has several high-risk investments. To balance her portfolio, she decided to invest in investment-grade corporate bonds. The bonds were issued at an interest rate of 9%.

The tenure is 20 years, and by the time these bonds mature, Sally will be nearing retirement. So, according to her portfolio manager, who recommended this investment, Sally now enjoys regular interest payments for the next 20 years. Upon maturity, she will get a lump sum amount (principal). As these bonds have a high credit rating, the default risk is considerably low.

Sally’s portfolio manager knows that the interest rate of 9% will likely not be able to beat inflation in the coming years. Hence, he also recommends some alternative investments. In this way, Sally can benefit from bond retirement or maturity after 20 years and enjoy a wholesome retirement while protecting her portfolio that contains high-risk, high-return investments as well.

Journal Entry

At the maturity date, bonds are retired with no gain or loss. When the bond matures, the company debits the bond payable account and credits the cash account as a journal entry for bond retirement.

Account	Debit ($)	Credit ($)
Bond payable	$$$
Cash		$$$

There may be a gain or loss on bond retirement before maturity. If the bond's net book value is more than the cash paid for redemption, the corporation may register a gain on bond retirement; if not, it may lose money on bond retirement before maturity.

The corporation can debit the bond's payable account and credit the gain on the retirement of the bonds and cash account to produce a journal entry for gain on bond retirement.

Account	Debit ($)	Credit ($)
Bonds payable	$$$
Gain on retirement of bonds		$$$
Cash		$$$

If the business experiences a loss on bond retirement, the entry differs. It can record the information by crediting the cash account and debiting the bonds payable for loss on bond retirement.

Account	Debit ($)	Credit ($)
Bonds payable	$$$
Loss on retirement of bonds	$$$
Cash		$$$

Investors can look into a bond retirement calculator to arrive at accurate amounts.

Frequently Asked Questions (FAQs)

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This article has been a guide to what is Bond Retirement. Here, we explain the concept in detail along with its journal entry and examples. You may also find some useful articles here –

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